Explanation:
A simple term structure model with no drift is given by . We are given that bps or $0.0075dw = 0.2dr = 0.0075 \times 0.2 = 0.00150.15\%$. The new spot rate is the initial rate plus the change in the rate: .
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Q.13 Using a term structure model with no drift and normally distributed rates assume that short term interest rates are 5%, annual volatility is 75 bps and after one month the realization of dw (a normally distributed random variable with mean 0 and standard deviation has an expected value of 0) is 0.2. What is the new spot rate?
A
5.15%
B
4.85%
C
3.50%
D
6.50%
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